J A N

2014

EFRAG Short Discussion Series THE EQUITY METHOD: A MEASUREMENT

BASIS OR ONE-LINE CONSOLIDATION?

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© 2014 European Financial Reporting Advisory Group (EFRAG).

We welcome views on any of the points addressed in this paper. Specifi c questions are given at the end of the document. These comments should be sent by email to commentletters@efrag.org or by post to

EFRAG35 Square de MeeûsB-1000 BrusselsBelgium

So as to arrive no later than 15 May 2014.

All comments will be placed on the public record unless confi dentiality is requested.

The EFRAG Short Discussion Series addresses topical and problematic issues with the aim of helping the IASB to address cross-cutting dilemmas in fi nancial reporting and stimulating debate among European constituents and beyond.

Further information about the work of EFRAG is available on www.efrag.org

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Table of Contents

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INTRODUCTION 4

OBJECTIVE OF THIS PAPER 5

BRIEF HISTORY OF THE EQUITY METHOD 5

MECHANICS OF THE EQUITY METHOD UNDER CURRENT IAS 28 7

Equity method as a measurement basis 8

Equity method as a one-line consolidation 9

RECENT DEVELOPMENTS 10

Recently proposed narrow-scope amendments to IAS 28 10 Unit of account 11

Shift to ‘exclusive control’ as the basis for consolidation 12

POSSIBLE CONSIDERATIONS OF THE ACCOUNTING OUTCOMES 13

Acquisition of an interest in an investee, including additional interests with no change in investment status 13

Measurement basis 13

One-line consolidation 13

Transactions with equity-accounted investees 14Measurement basis 14

One-line consolidation 15 Share of other net asset changes 15

Measurement basis 15

One-line consolidation 15

OTHER PERSPECTIVES ON THE EQUITY METHOD 16

SUMMARY 16

QUESTIONS TO CONSTITUENTS 18

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INTRODUCTION

1 Over the years, the IFRS Interpretations Committee has received numerous requests to clarify various aspects of accounting under the equity method in IAS 28 Investments in Associates and Joint Ventures (2011).

2 IAS 28 applies to all entities that are investors with joint control of, or signi� cant in� uence over, an investee, with some exceptions permitted. When developing IFRS 11 Joint Arrangements, the IASB decided to remove the option to apply proportionate consolidation to jointly controlled entities that existed under IAS 31 Interests in Joint Ventures. The scope of the equity method under IFRS has therefore been widened.

3 In May 2012, the IASB added a research project on the equity method of accounting to its agenda. However, this project remains at an early phase of development. As an interim solution, the IASB has been considering the various requests for guidance through narrow-scope amendments to IAS 28. In December 2012, the IASB published two Exposure Drafts addressing various inconsistencies within the Standard.

4 When responding to the two proposed amendments to IAS 28, EFRAG and other respondents expressed their support for the efforts of the IASB to address the diversity in practice but also commented that the proposed amendments lacked a clear conceptual basis and were potentially inconsistent with each other. It was noted that IAS 28 contains elements of both consolidation techniques and a measurement basis; however it was not always clear which of the two concepts should be applied to those situations that were not speci� cally addressed in IAS 28.

5 In December 2013, the IASB issued a proposal to allow entities to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate (parent only) � nancial statements. The basis for conclusions for that proposal does not explain why the equity method is an appropriate basis for accounting for investments in the separate � nancial statements. The proposals are intended to serve as a practical expedient to address a speci� c narrow-scope issue. A further exposure draft on the elimination of gains on downstream transactions between an investor and its equity-accounted investee is expected in early 2014.

6 EFRAG is also aware that accounting � rms have developed extensive application guidance on the application of the equity method for areas not addressed in IAS 28. The IFRS guidance published by accounting � rms often re� ects a range of views on accounting for speci� c transactions under the equity method and it is not always clear which of the two underlying concepts should be applied to those transactions and why.

7 Given the concerns and lack of clarity on the application of the equity method, it is increasingly important for those applying IFRS to have a better understanding of what the equity method aims to achieve in reporting for an investment in an associate or a joint venture (‘the investment’ or ‘investee’) in the statement of � nancial position and statement(s) of pro� t or loss and other comprehensive income.

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OBJECTIVE OF THIS PAPER

8 The objective of this paper is to highlight some considerations that are relevant in the discussion about the equity method and to ask for the views of constituents. This paper analyses the equity method from the perspective of the consolidated � nancial statements only. The impacts on the separate � nancial statements are not discussed.

9 This paper considers to what extent the equity method is a measurement basis, a one-line consolidation or whether it is a hybrid that has characteristics of both. The answers to these questions could affect the way standard setters further develop the equity method in the future.

10 This paper also considers whether recent developments in IFRS could assist in formulating a view on the equity method. However, the objective of the paper is not to reach a conclusion on this.

11 This paper intends to:

(a) assist the IASB to develop a clear set of principles for the basis of the equity method, before they address inconsistencies through additional narrow-scope amendments to IAS 28;

(b) contribute to the IASB’s research project on the equity method; and

(c) stimulate debate within Europe on the equity method of accounting.

12 The paper is also relevant to work the IASB is conducting on the revision to the Conceptual Framework for Financial Reporting and particularly the chapter on the Reporting Entity.

BRIEF HISTORY OF THE EQUITY METHOD

13 The equity method arose as a form of consolidation for subsidiaries in the UK and for certain subsidiaries in the US before the principles of full consolidation had been accepted.1 In particular, consolidated � nancial statements were seen as inappropriate because they showed assets and liabilities not owned by the reporting entity.

14 However, a cost basis for recognising investments in subsidiaries in the statement of � nancial position together with revenue based on the recognition of dividends was criticised for not recognising losses in subsidiaries on a timely manner and not adequately re� ecting the performance of subsidiaries given retention of earnings. The equity method had the bene� t of allowing the incorporation of actual results of subsidiaries into an entity’s � nancial statements.

1 An Analysis of the International Development of the Equity Method, Christopher Nobes, ABACUS, Vol. 38, No 1, 2002.

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15 The equity method therefore evolved, before the widespread use of consolidation, as a way of depicting the performance of subsidiary entities. It was seen as more appropriate than cost because:2

(a) ‘The cost method makes sense when there is uncertainty but that does not apply to subsidiaries over which there is full control of dividend policy.

(b) The status of the investments varies with the fortunes of the investees not with the movements of cash. Income accrues as the investments increase in value. Income accrues to the parent when it accrues to the subsidiary.

(c) The validity of the subsidiary’s pro� t calculation is as well established as the parent’s.

(d) Because companies plough back part of their pro� ts, the cost rule will probably understate parent income in prosperous periods.’

16 The equity method was later used to account for non-consolidated subsidiaries in the consolidated � nancial statements and for subsidiaries in the parent entity’s separate � nancial statements. In later years (1960s), it began to be recommended also for investments in certain non-subsidiary investees. It should be noted that the use of the equity method to account for subsidiaries in the parent entity’s separate � nancial statements has remained a long-standing practice that is still used in various jurisdictions across the world.

17 During the 1960s it was recognised that there was a case for an intermediate form of accounting, given the tendency for parent entities to conduct a signi� cant part of their businesses by acquiring substantial (but not controlling) stakes in other entities and exercising a signi� cant degree of in� uence over those acquired investments. Mere recognition of dividends was seen to be an inadequate measure of the results of the investments held by a parent entity. The equity method of accounting seemed to serve the need for such an intermediate form of accounting – which was based on the cost of an investment, recognition of dividends and ‘something else’ – in order to appropriately re� ect the results of the underlying investment in the � nancial statements of an investor.

18 However, the equity method was not supported by everyone. In the UK, for example, some criticised the method on the basis that it lacked an element of ‘conservatism’, following a court decision which interpreted the equity method as allowing for the recognition of unrealised pro� t. Nonetheless, international consensus on the equity method led to an amendment of the EC Seventh Directive (� nal version of 1983) to require the use of the equity accounting for associates of an investor.

2 Moonitz, 1944 in Nobes, 2002.

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19 Some European countries questioned this amendment given that historically the equity method had been used as a substitute for consolidation and was mainly used to account for ‘controlled’ entities (subsidiaries). In Germany, for example, the concept of a ‘group’ meant that associates were not group companies – only the parent company and its subsidiaries were. In other countries, like Sweden, doubt was cast over whether the equity method was a legally acceptable measurement method. Nobes (2002) states that these legal doubts were partially resolved by considering the equity method as a form of consolidation rather than as a measurement basis (referred to as ‘valuation method’ in the article).

20 Other countries, like Australia, amended their local GAAP (AASB 1016 in 1998) to require the use of the equity method in the consolidated accounts but, similar to Germany, associates were considered to be outside the group reporting entity therefore they too considered the equity accounting to be a measurement basis rather than a consolidation approach.

21 Despite this long history of the development of the equity method, IAS 28 does not state what the equity method is trying to portray. This leads to questions when there is no speci� c requirement in the Standard dealing with a particular type of transaction.

22 The equity method of accounting has features of both a consolidation approach (e.g. the elimination of pro� ts and losses from upstream and downstream transactions) and a measurement basis (e.g. the non-recognition of losses in excess of carrying value in most circumstances).

23 In summary, whether the equity method is considered to be a consolidation technique, a measurement basis or a hybrid with characteristics of both has been discussed for several decades and support for each of the approaches seems to have developed for different, often legal, reasons.

MECHANICS OF THE EQUITY METHOD UNDER CURRENT IAS 28

24 IAS 28 was originally issued in 1989 and has been subject to a number of amendments, most notably the amendments issued in December 2003 that resulted in a signi� cantly revised version of IAS 28 which became effective on or after 1 January 2005. However the basic mechanics of the equity method remained unchanged.

25 IAS 28 requires an investment to be accounted for using the equity method from the date on which it becomes an associate or a joint venture. Investments held through venture capital or other similar holdings may be held at fair value and are not covered in this paper.

MECHANICS OF THE EQUITY METHOD UNDER CURRENT IAS 28

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26 IAS 28 (paragraph 3) de� nes the equity method as:

‘a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s pro� t or loss includes its share of the investee’s pro� t or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income’.

27 This results in an investor’s pre-tax earnings including the investor’s proportional share of the post-tax earnings of the investee.

28 The problem is that different views of the concepts of the equity method lead to diverse accounting treatments for the same transaction.

Equity method as a measurement basis

29 IAS 28 contains certain requirements that indicate that the equity method is about measurement of an asset rather than being a one-line consolidation. For example, an investor does not account for its share of losses in an equity-accounted investee if those losses exceed the carrying amount of the investor’s interest unless the investor has an obligation to meet future losses. In that case it would be required to recognise that obligation as a liability.

30 Measuring investments at cost could be seen as inappropriate when the investor is able to control the payment of dividends from the investee. The earliest uses of the equity method, before the spread of consolidation, were to ensure the recognition of losses and restrict the potential for inappropriate recognition of gains.

31 Nobes (2002) describes this saying ‘this use of the equity method in investor � nancial statements could be seen as an example of attempts by accountants to express commercial substance over legal form. Since an investor could usually obtain its share of pro� ts in a subsidiary merely by requesting them, to recognise only dividends might seem like a legal nicety. A clue to another rationale for the use of equity accounting in investor � nancial statements can be found in the Dutch term for the method: intrinsieke waarde (intrinsic value)’.

32 The basis for conclusions in IAS 28 (paragraphs BC20, BC21 and BC30) refers to the equity method as a way to measure an investment in an associate and a joint venture (paragraph BC30). For example, paragraph BC20 refers to a situation where different measurement bases can be applied to portions of an investment in an associate in certain circumstances and refers to the equity method as being a way to measure an investment.

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33 More recently an IASB Board Member, Mr Ochi, dissented to the publication of ED/2012/3 IAS 28 Equity Method: Share of Other Net Asset Changes on the basis that, under the equity method of accounting, the investment is only adjusted for the post-acquisition changes in the investor’s share of the investee’s net assets. He added that, in his view, the equity method does not represent a one-line consolidation at the time of acquisition or disposal of the investment.

34 More generally, an asset is de� ned in paragraph 4.4(a) of the Conceptual Framework for Financial Reporting as ‘a resource controlled by the entity as a result of past events and from which future economic bene� ts are expected to � ow to the entity.’ As an investor does not control the underlying assets of an equity-accounted investee, they do not meet the de� nition of assets and should therefore not be recognised as if they were. The interest of an investor is therefore the investment in the investee, which meets the conceptual de� nition of an asset.

Equity method as a one-line consolidation

35 Paragraph 26 of IAS 28 notes that many procedures appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10 Consolidated Financial Statements. This same paragraph adds that the concepts used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an investee. IFRS 3 Business Combinations addresses the accounting for acquisition of subsidiaries.

36 IAS 28 generally requires unrealised pro� ts on transactions with equity-accounted investees to be eliminated to the extent of the investor’s interest in the investee. This is re� ected, for example, in the accounting relating to ‘upstream’ and ‘downstream’ transactions between an investor (including its consolidated subsidiaries) and its investee, in which the investor’s share of gains that arise from such transactions are eliminated. It is also re� ected in the accounting for contributions or sales of assets to an investee by an investor, except in the circumstances set out in paragraph 31 of IAS 28 which addresses a speci� c situation in which the investor is required to recognise the full gain or loss in its pro� t or loss. The elimination of pro� ts only to the extent of an investor’s interest re� ects a proprietary perspective to consolidation, as opposed to the entity perspective of IFRS 10.

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37 IAS 28 also says that the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an investee. Although the Standard does not speci� cally say that IFRS 3 should be applied to an acquisition of an investee, it does refer to the acquisition accounting principles in IFRS 3. Speci� cally, IAS 28 requires any difference between the cost of the investment and the investor’s share of the net fair value of the investee’s identi� able assets and liabilities to be accounted for as follows:

(a) goodwill relating to an investee is included in the carrying amount of the investment; or

(b) any excess of the investor’s share of the net fair value of the investee’s identi� able assets and liabilities over the cost of the investment is included as income in the determination of the investor’s share of the investee’s pro� t or loss in the period in which the investment is acquired.

RECENT DEVELOPMENTS

38 Recent developments in IFRS could assist in formulating a view on the equity method and what it aims to portray.

Recently proposed narrow-scope amendments to IAS 28

39 In December 2012, the IASB published the following two Exposure Drafts proposing to amend IAS 28:

(a) ED/2012/3 IAS 28 Equity Method: Share of Other Net Asset Changes – Addressed how an investor should recognise its share of changes in net assets of an investee not recognised in comprehensive income (‘other net asset changes’); and

(b) ED/2012/6 Sale or Contribution of Assets between an Investor and its Associate or Joint Venture – Addressed the acknowledged inconsistency between IFRS 10 and IAS 28 dealing with sale or contribution of assets between an investor and its investee.

40 Respondents to the Exposure Drafts mentioned above raised a number of concerns. In particular, they noted that:

(a) The diversity in the way the equity method was applied in practice arose mainly because of two different views of the concepts underlying the equity method. The narrow-scope amendments did not address these two concepts and were seen as a ‘patch’ to deal with missing guidance or addressing inconsistencies in IAS 28. Although there was some acceptance of these short-term pragmatic solutions to address diversity in practice, they did not present a robust solution to the underlying issues.

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(b) It was important for the IASB to establish a clear conceptual basis for the equity method (i.e. one-line consolidation or measurement basis) in order to address issues regarding its application.

41 In December 2013, the IASB issued a proposal to allow entities to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate � nancial statements.

42 A further exposure draft on how to account for the elimination of gains arising on downstream transactions when using the equity method is expected to be published soon. The IASB has tentatively decided that an investor should eliminate its share of gains and losses on transactions with an investee, even if the share of the gain it needs to eliminate exceeds the carrying amount of its interest in the investee. Any excess would be presented as a deferred gain.

Unit of account

43 Some of the IASB’s recent decisions explain that an investment in an associate or joint venture is a single unit of account, rather than the individual assets and liabilities of the investee. An investor has signi� cant in� uence over its investment in an associate or joint venture, not over the individual assets and liabilities of the investee. For example, the following amendments re� ect this view:

(a) A 2008 amendment to IAS 28, which is explained in paragraph BCZ45 of IAS 28 as ‘The Board decided that an entity should not allocate an impairment loss to any asset that forms part of the carrying amount of the investment in the associate or joint venture because the investment is the only asset that the entity controls and recognises’.

(b) A 2009 amendment to IAS 39 Financial Instruments: Recognition and Measurement, which is explained in paragraph BC24D as ‘...the acquisition of an interest in an associate represents the acquisition of a � nancial instrument. The acquisition of an interest in an associate does not represent an acquisition of a business with subsequent consolidation of the constituent net assets. The Board noted that paragraph 20 of IAS 28 explains only the methodology used to account for investments in associates.3 This should not be taken to imply that the principles for business combinations and consolidations can be applied by analogy to accounting for investments in associates and joint ventures.’

44 In February and March 2013, the IASB discussed the interaction between the unit of account of investments in subsidiaries, joint ventures and associates and their measurement at fair value. An Exposure Draft on this topic is expected to be published by the IASB soon. The IASB agenda papers noted that the question asked by constituents, related to whether the fair value of these investments should re� ect the measurement of the investment as a whole or of the individual � nancial instruments included within that investment. The IASB tentatively decided that the unit of account for investments in subsidiaries, joint ventures and associates is the investment as a whole.

3 Paragraph 26 in the current version of IAS 28.

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45 The IASB’s tentative decision that an investment in an associate is the investment as a whole could be further supported if the equity method was considered to be a measurement basis, rather than a one-line consolidation technique. It would also be consistent with other recent IASB decisions that the unit of account of an associate is the investment asset.

Shift to ‘exclusive control’ as the basis for consolidation

46 Another relevant consideration is the shift towards ‘exclusive control’ in the IASB’s recent conceptual thinking and standard setting process as re� ected in IFRS 3 and the new requirements of IFRS 10 and IFRS 11.

47 IFRS 10 focuses on a single basis of consolidation based on ‘control’. The de� nition of control, in the context of consolidated � nancial statements, focuses on a parent entity (the investor) and its subsidiaries. This is because all other types of investees held by a parent entity are excluded from the de� nition of the group (as de� ned in IFRS) in the context of the parent entity’s consolidated accounts.

48 The recognition principles in IFRS 3 also focus on the concept of ‘control’. They apply when an entity acquires another entity that is considered a business and obtains control over that entity. IFRS 3 explains that when control is achieved through a step acquisition (an acquisition in stages) the boundaries of the group change: the reporting entity gains control over a subsidiary, and any previously held interest is derecognised and remeasured at fair value at the date control is obtained and used in the determination of goodwill. The related gain or loss is recognised in full in pro� t or loss.

49 Similarly, when control is lost, the boundaries of the group change. IFRS 10 requires the former subsidiary to be derecognised and any retained interest to be remeasured at fair value, with the resulting gain recognised in full in pro� t or loss. If an investor retains an interest in a pre-existing subsidiary, that is regarded as being a new investment of a different nature (as the parent-subsidiary relationship ceases to exist).

50 However, changes in ownership interest in a subsidiary while retaining control are accounted for as transactions with owners in the capacity as owners. Contrary to step-acquisitions and loss of control, no gain or loss on such changes is recognised in pro� t or loss; instead, it is recognised in equity.

51 One could argue that the principle of exclusive control is also re� ected in the requirements of IFRS 11: proportionate consolidation is no longer permitted as a method for accounting for interests in joint arrangements (previously called joint ventures). Paragraph BC11 of IFRS 11 argues that the accounting for joint arrangements should re� ect the rights to assets and obligations for liabilities that the parties have as a result of their interests in a joint arrangement. If a party has neither rights to assets nor obligations for liabilities in an arrangement, it recognises its share in the joint arrangement under the equity method as this re� ects the fact that the party has only rights to the net assets of the joint arrangement.

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POSSIBLE CONSIDERATIONS OF THE ACCOUNTING OUTCOMES

52 Whether the equity method is considered to be primarily a method of consolidation, a measurement basis or a hybrid that has characteristics of both, could affect the way standard setters further develop the equity method in the future. In particular, the accounting for the following transactions could be signi� cantly different:

(a) acquisition of an interest in an investee, including additional interest with no change in investment status;

(b) transactions with equity-accounted investees; and

(c) accounting for share of other net asset changes.

53 A high-level analysis of the possible accounting outcomes of (a), (b) and (c), assuming that the equity method is either a measurement basis or a one-line consolidation, is set out in the paragraphs below.

Acquisition of an interest in an investee, including additional interests with no change in investment status

Measurement basis

54 Acquisition of an interest in an associate or joint venture would be accounted for at cost on the date of acquisition. Transaction costs incurred would be added to the cost of the underlying investment.

55 This principle would also apply when additional interests in the associate or joint venture are acquired, without a change in status in the investment (i.e. the investor continues to apply the equity method). Therefore, the consideration paid (including transaction costs) for the additional interest would be added to the investment measurement.

One-line consolidation

56 If the equity method were to be considered a pure consolidation approach, the principles in IFRS 3 would apply on the date of acquisition of an interest in an associate or joint venture. Transaction costs incurred would be expensed in pro� t or loss. Goodwill would be recognised (within the one line on the statement of � nancial position) to the extent of the excess of cost over the investor’s share of the fair value of identi� able net assets. ‘Negative goodwill’ would be accounted for in pro� t or loss.

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57 These principles would also apply when additional interests are acquired, without a change in status in the investment (e.g. an increase in the investor’s ownership interest from 20% to 25% while maintaining signi� cant in� uence).

Transactions with equity-accounted investees

58 IAS 28 provides guidance on various types of transactions between an investor and its associate or joint venture. As a general principle, IAS 28 requires ‘unrealised’ pro� ts and losses on transactions with equity-accounted investees to be eliminated to the extent of the investor’s interest in the investee except in the speci� c circumstance set out in paragraph 31 of IAS 28.

59 However, the Standard lacks guidance on various aspects of the accounting for transactions with investees. This has created uncertainty in the way the equity method should be applied to some transactions between an investor and its investee and has led to diversity in practice.

Measurement basis

60 If the equity method were considered to be a pure measurement basis – on the premise that the investment is a single unit of account that is measured using the equity method – then it could also be argued that a transaction between an investor and its non-controlled investee should be accounted for similar to any other transaction with a third party. Therefore an entity would recognise pro� ts and losses on transactions arising from transactions with equity-accounted investees in full in pro� t or loss.

61 In case of a sale or a contribution of an asset the investor would derecognise the underlying asset, and recognise the full gain or loss on the sale or contribution under applicable IFRS (for example under IAS 16 Property, Plant and Equipment). In the same way, an investor’s share of gains and losses on ‘upstream’ and ‘downstream’ transactions would be recognised in full.

62 It could also be argued that there is no need to differentiate between ‘realised’ and ‘unrealised’ gains and losses that arise on transactions with equity-accounted investees. In principle, the ‘realisation’ of such a gain or loss is not dependant on the future cash � ows of the underlying investee and hence the earnings process is considered complete. A loss would be recognised based on the impairment requirements of applicable IFRS.

63 One of the practical advantages of immediate recognition of a gain or loss is that it is simple to do. For example, there is no need to track the ‘unrealised’ gains and losses and determine when these should be recognised in pro� t or loss. There is also no need to decide whether the item sold or contributed, on which a gain or loss was made, meets the de� nition of a business.

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64 The investor should however be required to disclose information on gains or losses arising from transactions with its associates or joint ventures. Such related-party transaction information would be useful to users of � nancial statements.

One-line consolidation

65 The key principle would be to require gains and losses on all transactions with equity-accounted investees to be eliminated to the extent of the investor’s interest in the investee.

Share of other net asset changes

66 Such changes include those arising from movements in the share capital of the investee (e.g. when the investee issues additional shares to third parties or buys back shares from third parties) and movements in other components of the investee’s equity (e.g. when an investee accounts for an equity settled share-based payment transaction).

67 However further work would be needed to better understand the economic substance of such transactions and particularly the rights to bene� ts, if any, in the form of future cash � ows and obligations for liabilities, if any, they may bring to an investor. The views below re� ect some initial thoughts on the accounting outcomes under the equity method.

Measurement basis

68 If the net assets in the investee increase (as a result of the other net asset changes), it could be argued that the increase should not be recognised by an investor. In principle, an investor has not paid anything to increase its investment so there is nothing to recognise.

69 Another view might be to consider whether an investor will bene� t from future economic bene� ts from the transaction undertaken by the investee. If it will, the future bene� ts (for example in the form of additional cash � ows) should be re� ected by the investor in the amount of the investment it holds. However any increase in value should be recognised in either pro� t or loss or other comprehensive income as the investee is not part of the group; therefore transactions involving the investee, directly or indirectly, should not be accounted for in equity.

70 Changes in other net assets that result in decreases in future cash � ows should be re� ected by recognising an impairment loss on the investment. This would be recognised in pro� t or loss in accordance with applicable IFRS.

One-line consolidation

71 One view might be to consider whether an investor will bene� t from future economic bene� ts from the transaction. If it will, the future cash � ows should be re� ected in the amount of the investment. In principle, the amount should not be recognised in equity given that neither an associate nor a joint venture are part of the group as de� ned in IFRS.

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72 Decreases in future cash � ows should be re� ected by recognising an impairment loss on the investment. This would be recognised in pro� t or loss in accordance with applicable IFRS.

OTHER PERSPECTIVES ON THE EQUITY METHOD

73 The analysis above implicitly assumes that the equity method is either a one-line consolidation or a measurement basis. However these are not the only ways in which one could look at the equity method. For example, it would be possible to view the equity method in one of the following ways:

(a) Equity method as a hybrid approach – This view regards the equity method as an approach that has characteristics of both a one-line consolidation and a measurement basis. Depending on the nature of the transaction or event, the equity method could prescribe a treatment that was either closely aligned to the one approach or the other.

(b) Equity method as a one-line consolidation based on a proprietary perspective – Even if the equity method is regarded as a form of one-line consolidation, it is not necessary that the consolidation procedures applied are aligned with those required by IFRS 10, which is based on the entity concept. Instead, given the different nature of investments in associates and joint ventures, the use of consolidation procedures based on a proprietary perspective might be more appropriate and relevant.

It should be noted that the above list is not exhaustive and that further perspectives may exist.

SUMMARY

74 The historical development of the equity method was that of a one-line consolidation, re� ecting the results of subsidiaries in the � nancial statements of a parent entity in a time before consolidation had evolved, and when not all controlled companies were consolidated.

75 However the recent thinking of the IASB when developing IFRS 3, IFRS 10 and IFRS 11 emphasises the concept of ‘exclusive control’ in the context of acquiring control and losing control to determine the boundary of a reporting entity and of its assets and liabilities and their consequential accounting. Neither an associate nor a joint venture are controlled by an investor, and are therefore not part of the group under IFRS. For these reasons, it could be argued that the equity method cannot conceptually be a one-line consolidation.

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76 As a basis to portray performance of an investment in an associate or a joint venture, some would conclude that the equity method is arguably superior in terms of relevance of information provided by both cost and fair value, for the same reasons these came to be considered inappropriate for holding company � nancial statements before consolidation. Proponents of this view are likely to believe there are valid arguments to maintain the equity method as a means to account for interests in associates and joint ventures.

77 A wider agreement on the conceptual underpinnings of the equity method will contribute to improving the quality of � nancial reporting and assist the standard setting process.

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Questions to constituents

We would welcome views, sent to commentletters@efrag.org by 15 May 2014, on any of the points addressed in this paper. In particular:

78 Do you view the equity method under IAS 28 as a measurement basis, a one-line consolidation approach or something different? Please explain.

79 If you view the equity method under IAS 28 as being akin to a one-line consolidation approach, do you believe that the consolidation procedures should be based on the entity concept in IFRS 10 or not (e.g. based on a proprietary approach)? Please explain.

80 Do you think that for some transactions a measurement basis appropriately refl ects the underlying economics of the transaction and provides useful information, whilst for other transactions a one-line consolidation approach is preferable? Could you provide some examples of transactions where application of either of the concepts would be more appropriate?

81 Have you had practical problems in applying IAS 28, because the underlying nature of the equity method is unclear? If so, could you please describe those problems and how you addressed them?

EFRAG receives � nancial support from the

European Union-DG Internal Market and

Services. The contents of this paper is the

sole responsibility of EFRAG and can under no

circumstances be regarded as re� ecting the

position of the European Union.